March 9, 2015

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March 9, 2015

The latest in Stern analysis can be found in a fascinating story of mystery, money, and international intrigue. Last month, the Eleventh Circuit in In re Fisher Island Invs., Inc., No. 12-15595, 2015 WL 729689 (11th Cir. Feb. 20, 2015), upheld the bankruptcy court’s ruling as to the ownership of putative debtors, despite a party’s objection to the bankruptcy court’s constitutional authority to decide the putative debtors’ ownership under Stern v. Marshall.[1]

Fisher Island Investments is merely one part of the global litigation following the unexpected death of Arkadi Patarkatsishvili regarding the disputed ownership of three trusts—purportedly worth billions of dollars—between two competing groups: the Redmond Group and the Zeltser Group. Following litigation in the Republic of Georgia, the United Kingdom, Liechtenstein, the British territory in Gibraltar, and state litigation in the United States, a group of six entities (the “Petitioning Creditors”) filed three separate involuntary Chapter 11 bankruptcy petitions in the United States Bankruptcy Court for the Southern District of Florida against the three trusts (the “Alleged Debtors”) based on an unpaid promissory note purportedly executed by the Alleged Debtors. Two sets of attorneys, one representing the Redmond Group and the other representing the Zeltser Group, entered appearances, both purporting to act on behalf of the Alleged Debtors. The Zeltser Group asked the bankruptcy court to deny the relief sought by the Petitioning Creditors until the court resolved the issue of whether the Zeltser Group or the Redmond Group owned the trusts and, therefore, which group had the authority to act on behalf of the Alleged Debtors.[2]

Following a hearing, an unfavorable report by the Chapter 11 Examiner appointed to investigate the ownership issue, and the Supreme Court’s issuance of the Stern opinion, the Zeltser Group moved for partial summary judgment on the ownership issue. The bankruptcy court denied the Zeltser Group’s partial summary judgment and then later, sua sponte, entered an order granting summary judgment in favor of the Redmond Group. Three groups appealed: the Zeltser Group, five non-party entities affiliated with the Zeltser Group, and the Petitioning Creditors.

Prior to the grant of summary judgment, the Zeltser Group filed a motion in the district court to withdraw reference of the ownership issue, pursuant to 28 U.S.C. § 157(d) and Stern, in each bankruptcy case, objecting to the bankruptcy court’s adjudication of the ownership issue. At first, the Zeltser Group contended that the ownership issue was not a “core” matter.[3] Later, the Zeltser Group conceded that the ownership issue was a “core” matter, but asserted that it was entitled to a trial in an Article III court as a result of Stern—even though it had consented to a trial in the bankruptcy court before the Stern decision was issued. The district court denied the Zeltser Group’s motion, characterizing it as a “belated change of heart” and finding that the ownership issue was a “core” matter within the bankruptcy court’s jurisdiction. The district court commented that, unlike the state-law counterclaim at issue in Stern, the ownership issue was “deeply embedded” and required the bankruptcy court’s determination in order for the court to rule on the merits of the creditors’ claims. Alternatively, the district court held that the Zeltser Group clearly waived any right it may have had to a trial before an Article III judge. The Zeltser Group appealed the district court’s order to the Eleventh Circuit Court of Appeals, which affirmed in whole.

On appeal, the Zeltser Group asserted that an objection to a bankruptcy court’s constitutional authority under Stern’s interpretation of 18 U.S.C. § 157 cannot be waived and that its voluntary pre-Stern participation in pre-trial proceedings did not constitute consent to a non-jury trial before the bankruptcy court. The Eleventh Circuit agreed that the ownership issue was clearly a “core” matter because the resolution of the ownership issue was critical to the administration of the Alleged Debtors’ estates—namely whether the Petitioning Creditors’ claims would be admitted or contested. Therefore, the bankruptcy court necessarily had to determine who owned the Alleged Debtors to adjudicate the validity of the Petitioning Creditors’ claims. The Court found Stern to be “wholly inapplicable,” noting that, while the Zeltser Group’s claim was a state-law claim that, like the counterclaim in Stern, did not involve “public rights” or stem from a federal statutory scheme and would not be determined by bankruptcy law, the ownership issue did not simply have “some bearing” on the bankruptcy proceedings. Rather, the bankruptcy court could not undertake the bankruptcy proceedings without first determining the threshold issue of ownership.[4] Furthermore, even if the ownership issue were a “non-core” matter, the Court found that the Zeltser Group “expressly consented to the bankruptcy court’s final adjudication of the ownership issue and waived any argument to the contrary” by making representations to the bankruptcy court, voluntarily participating in discovery, and appearing at a hearing before the bankruptcy court—indicating its willingness for the bankruptcy court to decide the ownership issue.

[1]Stern v. Marshall, 546 U.S.___, 131 S. Ct. 2594 (2011), involved a voluntary bankruptcy proceeding in which a creditor filed a defamation claim in the debtor’s case and the debtor filed a state law counterclaim for tortious interference against the creditor. The bankruptcy court entered final judgment on the creditor’s claim and the debtor’s counterclaim, finding the counterclaim to be a “core” proceeding under § 157, which lists “counterclaims against persons filing claims against the estate” as one of the sixteen named types of “core” proceedings. See 28 U.S.C. § 157. The United States Supreme Court found that the final judgment violated Article III of the Constitution, even though the bankruptcy court had statutory authority to enter final judgment on the counterclaim under § 157. Stern, 131 S. Ct. at 2601, 2620. The Supreme Court found that “Congress may not bypass Article III simply because a proceeding may have some bearing on a bankruptcy case; the question is whether the action at issue stems from the bankruptcy itself or would necessarily be resolved in the claims allowance process.” Id. at 2618.

[2] Notably, the Redmond Group sought to contest the allegations in the involuntary petitions, while the Zeltser Group sought to admit to the allegations and consent to the relief requested by the Petitioning Creditors.

[3] The Judicial Code divides all matters that may be referred to a bankruptcy court into two categories. See 28 U.S.C. § 157. On one hand are “core” proceedings—those that “aris[e] under title 11” or “aris[e] in a case under title 11.” Id. On the other hand are “non-core” proceedings—those that are “otherwise related to a case under title 11”). Id. The “core”/ “non-core” distinction matters because it affects the manner in which a bankruptcy court may act and whether the court has the authority to hear and enter final judgments in a proceeding (“core” proceedings), subject to the Article III issues identified in Stern, or whether it may only submit proposed findings of fact and conclusions of law to the district court, which then may enter final judgment after de novo review (“non-core” proceedings). Id. Note, however, that the issue of whether parties may consent to the entry of final judgment by a bankruptcy court in “non-core” proceedings is currently before the United States Supreme Court in Wellness Int’l Network, Ltd v. Sharif.

[4] The Court also commented that, although the relevant parties did not file a proof of claim, per the holding in Stern, the Zeltser Group “invoked the aid of the bankruptcy court by asking it to adjudicate the ownership issue. As a result, it must abide by the consequences of that decision.”

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